US Treasury And Federal Reserve said last spring that there would be a little “sluggishness” in the economy even while admitting to the structural cracks in the foundation of the economy – did they not understand the principles of “growth” and substance? or what?

Cavuto on FoxNews is busily talking about the Republican’s plan to pursue the “underground economy” in order to close the budget gap. It doesn’t matter that their friends are stealing millions of dollars in taxpayer money every day and have been doing that for thirty years, apparently they think the poor people have caused the problems – as usual.

– my note

***

April 15th, 2008

Fourth largest US bank posts losses, seeks $7-bn infusion

April 15th, 2008 – 12:57 am ICT by admin

DPA New York, April 14 (DPA) Wachovia Corp, the fourth largest US bank, Monday reported unexpected losses due to bad California home loans and said it was seeking a $7-billion infusion from stock sales. Shares will be sold at $24 each, 14 percent less than last week’s closing price.

First quarter losses were $393 million compared with earnings of $2.3 billion in the same period last year, the North Carolina-based company said in a statement.

The drastic drop is just the latest in the roiling sub-prime mortgage credit crisis in the US that has spread through the US and abroad. The International Monetary Fund last week estimated that the total world loss from the crisis could be near $1 trillion when all is said and done.

Wachovia plans to cut 500 investment-banking jobs, and will cut dividends to preserve $2 billion in capital, according to an analyst’s report from Goldman Sachs Group Inc.

Washington Mutual Inc, the largest US savings and loan, got $7 billion last week from investors led by David Bonderman’s TPG Inc.

In all, banks and securities firms, including Citigroup Inc and Lehman Brothers Holdings Inc, have raised about $140 billion since last year after more than $245 billion of losses tied to the collapse of the sub-prime mortgage market, according to data compiled by Bloomberg financial news.
DPA

Testimony

Chairman Ben S. Bernanke

The economic outlook

Before the Committee on the Budget, U.S. House of Representatives

** January 17, 2008 **

Chairman Spratt, Representative Ryan, and other members of the Committee, I am pleased to be here to offer my views on the near-term economic outlook and related issues.

Developments in Financial Markets
Since late last summer, financial markets in the United States and in a number of other industrialized countries have been under considerable strain. Heightened investor concerns about the credit quality of mortgages, especially subprime mortgages with adjustable interest rates, triggered the financial turmoil.

Notably, as the rising rate of delinquencies of subprime mortgages threatened to impose losses on holders of even highly rated securities, investors were led to question the reliability of the credit ratings for a range of financial products, including structured credit products and various special-purpose vehicles. As investors lost confidence in their ability to value complex financial products, they became increasingly unwilling to hold such instruments. As a result, flows of credit through these vehicles have contracted significantly.

As these problems multiplied, money center banks and other large financial institutions, which in many cases had served as sponsors of these financial products, came under increasing pressure to take the assets of the off-balance-sheet vehicles onto their own balance sheets. Bank balance sheets were swelled further by holdings of nonconforming mortgages, leveraged loans, and other credits that the banks had extended but for which well-functioning secondary markets no longer existed.

Even as their balance sheets expanded, banks began to report large losses, reflecting marked declines in the market prices of mortgages and other assets. Thus, banks too became subject to valuation uncertainty, as could be seen in the sharp movements in their share prices and in other market indicators such as quotes on credit default swaps.

The combination of larger balance sheets and unexpected losses prompted banks to become protective of their liquidity and balance sheet capacity and thus to become less willing to provide funding to other market participants, including other banks. Banks have also evidently become more restrictive in their lending to firms and households. More-expensive and less-available credit seems likely to impose a measure of restraint on economic growth.

The Outlook for the Real Economy
To date, the largest effects of the financial turmoil appear to have been on the housing market, which, as you know, has deteriorated significantly over the past two years or so. The virtual shutdown of the subprime mortgage market and a widening of spreads on jumbo mortgage loans have further reduced the demand for housing, while foreclosures are adding to the already-elevated inventory of unsold homes.

New home sales and housing starts have both fallen by about half from their respective peaks. The number of homes in inventory has begun to edge down, but at the current sales pace the months’ supply of new homes has continued to climb, and home prices are falling in many parts of the country. The slowing in residential construction, which subtracted about 1 percentage point from the growth rate of real gross domestic product in the third quarter of 2007, likely curtailed growth even more in the fourth quarter, and it may continue to be a drag on growth for a good part of this year as well.

Recently, incoming information has suggested that the baseline outlook for real activity in 2008 has worsened and that the downside risks to growth have become more pronounced. In particular, a number of factors, including continuing increases in energy prices, lower equity prices, and softening home values, seem likely to weigh on consumer spending as we move into 2008.

Consumer spending also depends importantly on the state of the labor market, as wages and salaries are the primary source of income for most households. Labor market conditions in December were disappointing; the unemployment rate increased 0.3 percentage point, to 5.0 percent from 4.7 percent in November, and private payroll employment declined. Employment in residential construction posted another substantial reduction, and employment in manufacturing and retail trade also decreased significantly. Employment in services continued to grow, but at a slower pace in December than in earlier months. It would be a mistake to read too much into one month’s data. However, developments in the labor market will bear close attention.

In the business sector, investment in equipment and software appears to have been sluggish in the fourth quarter, while nonresidential construction grew briskly. In light of the softening in economic activity and the adverse developments in credit markets, growth in both types of investment spending seems likely to slow in coming months. Outside the United States, however, economic activity in our major trading partners has continued to expand vigorously. U.S. exports will likely continue to grow at a healthy pace in coming quarters, providing some impetus to the domestic economy.

Financial conditions continue to pose a downside risk to the outlook. Market participants still express considerable uncertainty about the appropriate valuation of complex financial assets and about the extent of additional losses that may be disclosed in the future. On the whole, despite improvements in some areas, the financial situation remains fragile, and many funding markets remain impaired. Adverse economic or financial news thus has the potential to increase financial strains and to lead to further constraints on the supply of credit to households and businesses.

Even as the outlook for real activity has weakened, some important developments have occurred on the inflation front. Most notably, the same increase in oil prices that may be a negative influence on growth is also lifting overall consumer prices.

Last year, food prices also increased exceptionally rapidly by recent standards, further boosting overall consumer price inflation. The most recent reading on overall personal consumption expenditure inflation showed that prices in November were 3.6 percent higher than they were a year earlier. Core price inflation (which excludes prices of food and energy) has stepped up recently as well, with November prices up almost 2-1/4 percent from a year earlier. Part of this rise may reflect pass-through of energy costs to the prices of core consumer goods and services, as well as the effects of the depreciation of the dollar on import prices, although some other prices–such as those for some medical and financial services–have also accelerated lately.1

Thus far, the public’s expectations of future inflation appear to have remained reasonably well anchored, and pressures on resource utilization have diminished a bit. Further, futures markets suggest that food and energy prices will decelerate over the coming year. Given these factors, overall and core inflation should moderate this year and next, so long as the public’s confidence in the Federal Reserve’s commitment to price stability is unshaken.

However, any tendency of inflation expectations to become unmoored or for the Fed’s inflation-fighting credibility to be eroded could greatly complicate the task of sustaining price stability and reduce the central bank’s policy flexibility to counter shortfalls in growth in the future. Accordingly, in the months ahead we will be closely monitoring the inflation situation, particularly inflation expectations.

Monetary Policy Response
The Federal Reserve has taken a number of steps to help markets return to more orderly functioning and to foster its economic objectives of maximum sustainable employment and price stability. Broadly, the Federal Reserve’s response has followed two tracks: efforts to improve market liquidity and functioning and the pursuit of our macroeconomic objectives through monetary policy.

To help address the significant strains in short-term money markets, the Federal Reserve has taken a range of steps. Notably, on August 17, the Federal Reserve Board cut the discount rate–the rate at which it lends directly to banks–by 50 basis points, or 1/2 percentage point, and it has since maintained the spread between the federal funds rate and the discount rate at 50 basis points, rather than the customary 100 basis points.

In addition, the Federal Reserve recently unveiled a term auction facility, or TAF, through which prespecified amounts of discount window credit can be auctioned to eligible borrowers. The goal of the TAF is to reduce the incentive for banks to hoard cash and increase their willingness to provide credit to households and firms. In December, the Fed successfully auctioned $40 billion through this facility. And, as part of a coordinated operation, the European Central Bank and the Swiss National Bank lent an additional $24 billion to banks in their respective jurisdictions.

This month, the Federal Reserve is auctioning $60 billion in twenty-eight-day credit through the TAF, to be spread across two auctions. TAF auctions will continue as long as necessary to address elevated pressures in short-term funding markets, and we will continue to work closely and cooperatively with other central banks to address market strains that could hamper the achievement of our broader economic objectives.

Although the TAF and other liquidity-related actions appear to have had some positive effects, such measures alone cannot fully address fundamental concerns about credit quality and valuation, nor do these actions relax the balance sheet constraints on financial institutions. Hence, they alone cannot eliminate the financial restraints affecting the broader economy. Monetary policy (that is, the management of the short-term interest rate) is the Fed’s best tool for pursuing our macroeconomic objectives, namely to promote maximum sustainable employment and price stability.

Monetary policy has responded proactively to evolving conditions. As you know, the Federal Open Market Committee (FOMC) cut its target for the federal funds rate by 50 basis points at its September meeting and by 25 basis points each at the October and December meetings. In total, therefore, we have brought the federal funds rate down by 1 percentage point from its level just before the financial strains emerged.

The Federal Reserve took these actions to help offset the restraint imposed by the tightening of credit conditions and the weakening of the housing market. However, in light of recent changes in the outlook for and the risks to growth, additional policy easing may well be necessary. The FOMC will, of course, be carefully evaluating incoming information bearing on the economic outlook. Based on that evaluation, and consistent with our dual mandate, we stand ready to take substantive additional action as needed to support growth and to provide adequate insurance against downside risks.

Financial and economic conditions can change quickly. Consequently, the FOMC must remain exceptionally alert and flexible, prepared to act in a decisive and timely manner and, in particular, to counter any adverse dynamics that might threaten economic or financial stability.

A number of analysts have raised the possibility that fiscal policy actions might usefully complement monetary policy in supporting economic growth over the next year or so. I agree that fiscal action could be helpful in principle, as fiscal and monetary stimulus together may provide broader support for the economy than monetary policy actions alone. But the design and implementation of the fiscal program are critically important. A fiscal initiative at this juncture could prove quite counterproductive, if (for example) it provided economic stimulus at the wrong time or compromised fiscal discipline in the longer term.

To be useful, a fiscal stimulus package should be implemented quickly and structured so that its effects on aggregate spending are felt as much as possible within the next twelve months or so. Stimulus that comes too late will not help support economic activity in the near term, and it could be actively destabilizing if it comes at a time when growth is already improving. Thus, fiscal measures that involve long lead times or result in additional economic activity only over a protracted period, whatever their intrinsic merits might be, will not provide stimulus when it is most needed.

Any fiscal package should also be efficient, in the sense of maximizing the amount of near-term stimulus per dollar of increased federal expenditure or lost revenue. Finally, any program should be explicitly temporary, both to avoid unwanted stimulus beyond the near-term horizon and, importantly, to preclude an increase in the federal government’s structural budget deficit. As I have discussed on other occasions, the nation faces daunting long-run budget challenges associated with an aging population, rising health-care costs, and other factors. A fiscal program that increased the structural budget deficit would only make confronting those challenges more difficult.

Thank you. I would be pleased to take your questions.

Footnotes

1. Prices for some financial services are implicit; for example, depositors may pay for “free” checking services only indirectly, by accepting a lower interest rate on their deposits. The Bureau of Labor Statistics uses estimates of such prices, as well as other nonmarket prices, in calculating the inflation rate.

Testimony

Chairman Ben S. Bernanke

Semiannual Monetary Policy Report to the Congress

Before the Committee on Financial Services, U.S. House of Representatives

February 27, 2008

Chairman Bernanke presented identical testimony before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, on February 28, 2008

Chairman Frank, Ranking Member Bachus, and other members of the Committee, I am pleased to present the Federal Reserve’s Monetary Policy Report to the Congress. In my testimony this morning I will briefly review the economic situation and outlook, beginning with developments in real activity and inflation, then turn to monetary policy. I will conclude with a quick update on the Federal Reserve’s recent actions to help protect consumers in their financial dealings.

The economic situation has become distinctly less favorable since the time of our July report. Strains in financial markets, which first became evident late last summer, have persisted; and pressures on bank capital and the continued poor functioning of markets for securitized credit have led to tighter credit conditions for many households and businesses. The growth of real gross domestic product (GDP) held up well through the third quarter despite the financial turmoil, but it has since slowed sharply. Labor market conditions have similarly softened, as job creation has slowed and the unemployment rate–at 4.9 percent in January–has moved up somewhat.

Many of the challenges now facing our economy stem from the continuing contraction of the U.S. housing market. In 2006, after a multiyear boom in residential construction and house prices, the housing market reversed course. Housing starts and sales of new homes are now less than half of their respective peaks, and house prices have flattened or declined in most areas. Changes in the availability of mortgage credit amplified the swings in the housing market. During the housing sector’s expansion phase, increasingly lax lending standards, particularly in the subprime market, raised the effective demand for housing, pushing up prices and stimulating construction activity. As the housing market began to turn down, however, the slump in subprime mortgage originations, together with a more general tightening of credit conditions, has served to increase the severity of the downturn. Weaker house prices in turn have contributed to the deterioration in the performance of mortgage-related securities and reduced the availability of mortgage credit.

The housing market is expected to continue to weigh on economic activity in coming quarters. Homebuilders, still faced with abnormally high inventories of unsold homes, are likely to cut the pace of their building activity further, which will subtract from overall growth and reduce employment in residential construction and closely related industries.

Consumer spending continued to increase at a solid pace through much of the second half of 2007, despite the problems in the housing market, but it appears to have slowed significantly toward the end of the year. The jump in the price of imported energy, which eroded real incomes and wages, likely contributed to the slowdown in spending, as did the declines in household wealth associated with the weakness in house prices and equity prices. Slowing job creation is yet another potential drag on household spending, as gains in payroll employment averaged little more than 40,000 per month during the three months ending in January, compared with an average increase of almost 100,000 per month over the previous three months. However, the recently enacted fiscal stimulus package should provide some support for household spending during the second half of this year and into next year.

The business sector has also displayed signs of being affected by the difficulties in the housing and credit markets. Reflecting a downshift in the growth of final demand and tighter credit conditions for some firms, available indicators suggest that investment in equipment and software will be subdued during the first half of 2008. Likewise, after growing robustly through much of 2007, nonresidential construction is likely to decelerate sharply in coming quarters as business activity slows and funding becomes harder to obtain, especially for more speculative projects. On a more encouraging note, we see few signs of any serious imbalances in business inventories aside from the overhang of unsold homes. And, as a whole, the nonfinancial business sector remains in good financial condition, with strong profits, liquid balance sheets, and corporate leverage near historical lows.

In addition, the vigor of the global economy has offset some of the weakening of domestic demand. U.S. real exports of goods and services increased at an annual rate of about 11 percent in the second half of last year, boosted by continuing economic growth abroad and the lower foreign exchange value of the dollar. Strengthening exports, together with moderating imports, have in turn led to some improvement in the U.S. current account deficit, which likely narrowed in 2007 (on an annual basis) for the first time since 2001. Although recent indicators point to some slowing of foreign economic growth, U.S. exports should continue to expand at a healthy pace in coming quarters, providing some impetus to domestic economic activity and employment.

As I have mentioned, financial markets continue to be under considerable stress. Heightened investor concerns about the credit quality of mortgages, especially subprime mortgages with adjustable interest rates, triggered the financial turmoil. However, other factors, including a broader retrenchment in the willingness of investors to bear risk, difficulties in valuing complex or illiquid financial products, uncertainties about the exposures of major financial institutions to credit losses, and concerns about the weaker outlook for economic growth, have also roiled the financial markets in recent months.

To help relieve the pressures in the market for interbank lending, the Federal Reserve–among other actions–recently introduced a term auction facility (TAF), through which prespecified amounts of discount window credit are auctioned to eligible borrowers, and we have been working with other central banks to address market strains that could hamper the achievement of our broader economic objectives. These efforts appear to have contributed to some improvement in short-term funding markets. We will continue to monitor financial developments closely.

As part of its ongoing commitment to improving the accountability and public understanding of monetary policy making, the Federal Open Market Committee (FOMC) recently increased the frequency and expanded the content of the economic projections made by Federal Reserve Board members and Reserve Bank presidents and released to the public.

The latest economic projections, which were submitted in conjunction with the FOMC meeting at the end of January and which are based on each participant’s assessment of appropriate monetary policy, show that real GDP was expected to grow only sluggishly in the next few quarters and that the unemployment rate was seen as likely to increase somewhat. In particular, the central tendency of the projections was for real GDP to grow between 1.3 percent and 2.0 percent in 2008, down from 2-1/2 percent to 2-3/4 percent projected in our report last July.

FOMC participants’ projections for the unemployment rate in the fourth quarter of 2008 have a central tendency of 5.2 percent to 5.3 percent, up from the level of about 4-3/4 percent projected last July for the same period. The downgrade in our projections for economic activity in 2008 since our report last July reflects the effects of the financial turmoil on real activity and a housing contraction that has been more severe than previously expected.

By 2010, our most recent projections show output growth picking up to rates close to or a little above its longer-term trend and the unemployment rate edging lower; the improvement reflects the effects of policy stimulus and an anticipated moderation of the contraction in housing and the strains in financial and credit markets. The incoming information since our January meeting continues to suggest sluggish economic activity in the near term.

The risks to this outlook remain to the downside. The risks include the possibilities that the housing market or labor market may deteriorate more than is currently anticipated and that credit conditions may tighten substantially further.

Consumer price inflation has increased since our previous report, in substantial part because of the steep run-up in the price of oil. Last year, food prices also increased significantly, and the dollar depreciated. Reflecting these influences, the price index for personal consumption expenditures (PCE) increased 3.4 percent over the four quarters of 2007, up from 1.9 percent in 2006.

Core price inflation–that is, inflation excluding food and energy prices–also firmed toward the end of the year. The higher recent readings likely reflected some pass-through of energy costs to the prices of core consumer goods and services as well as the effect of the depreciation of the dollar on import prices. Moreover, core inflation in the first half of 2007 was damped by a number of transitory factors–notably, unusually soft prices for apparel and for financial services–which subsequently reversed. For the year as a whole, however, core PCE prices increased 2.1 percent, down slightly from 2006.

The projections recently submitted by FOMC participants indicate that overall PCE inflation was expected to moderate significantly in 2008, to between 2.1 percent and 2.4 percent (the central tendency of the projections). A key assumption underlying those projections was that energy and food prices would begin to flatten out, as was implied by quotes on futures markets. In addition, diminishing pressure on resources is also consistent with the projected slowing in inflation.

The central tendency of the projections for core PCE inflation in 2008, at 2.0 percent to 2.2 percent, was a bit higher than in our July report, largely because of some higher-than-expected recent readings on prices. Beyond 2008, both overall and core inflation were projected to edge lower, as participants expected inflation expectations to remain reasonably well-anchored and pressures on resource utilization to be muted. The inflation projections submitted by FOMC participants for 2010–which ranged from 1.5 percent to 2.0 percent for overall PCE inflation–were importantly influenced by participants’ judgments about the measured rates of inflation consistent with the Federal Reserve’s dual mandate and about the time frame over which policy should aim to attain those rates.

The rate of inflation that is actually realized will of course depend on a variety of factors. Inflation could be lower than we anticipate if slower-than-expected global growth moderates the pressure on the prices of energy and other commodities or if rates of domestic resource utilization fall more than we currently expect. Upside risks to the inflation projection are also present, however, including the possibilities that energy and food prices do not flatten out or that the pass-through to core prices from higher commodity prices and from the weaker dollar may be greater than we anticipate.

Indeed, the further increases in the prices of energy and other commodities in recent weeks, together with the latest data on consumer prices, suggest slightly greater upside risks to the projections of both overall and core inflation than we saw last month. Should high rates of overall inflation persist, the possibility also exists that inflation expectations could become less well anchored. Any tendency of inflation expectations to become unmoored or for the Fed’s inflation-fighting credibility to be eroded could greatly complicate the task of sustaining price stability and could reduce the flexibility of the FOMC to counter shortfalls in growth in the future. Accordingly, in the months ahead, the Federal Reserve will continue to monitor closely inflation and inflation expectations.

Let me turn now to the implications of these developments for monetary policy. The FOMC has responded aggressively to the weaker outlook for economic activity, having reduced its target for the federal funds rate by 225 basis points since last summer. As the Committee noted in its most recent post-meeting statement, the intent of those actions has been to help promote moderate growth over time and to mitigate the risks to economic activity.

A critical task for the Federal Reserve over the course of this year will be to assess whether the stance of monetary policy is properly calibrated to foster our mandated objectives of maximum employment and price stability in an environment of downside risks to growth, stressed financial conditions, and inflation pressures.

In particular, the FOMC will need to judge whether the policy actions taken thus far are having their intended effects. Monetary policy works with a lag. Therefore, our policy stance must be determined in light of the medium-term forecast for real activity and inflation as well as the risks to that forecast. Although the FOMC participants’ economic projections envision an improving economic picture, it is important to recognize that downside risks to growth remain. The FOMC will be carefully evaluating incoming information bearing on the economic outlook and will act in a timely manner as needed to support growth and to provide adequate insurance against downside risks.

Finally, I would like to say a few words about the Federal Reserve’s recent actions to protect consumers in their financial transactions. In December, following up on a commitment I made at the time of our report last July, the Board issued for public comment a comprehensive set of new regulations to prohibit unfair or deceptive practices in the mortgage market, under the authority granted us by the Home Ownership and Equity Protection Act of 1994. The proposed rules would apply to all mortgage lenders and would establish lending standards to help ensure that consumers who seek mortgage credit receive loans whose terms are clearly disclosed and that can reasonably be expected to be repaid.

Accordingly, the rules would prohibit lenders from engaging in a pattern or practice of making higher-priced mortgage loans without due regard to consumers’ ability to make the scheduled payments. In each case, a lender making a higher-priced loan would have to use third-party documents to verify the income relied on to make the credit decision. For higher-priced loans, the proposed rules would require the lender to establish an escrow account for the payment of property taxes and homeowners’ insurance and would prevent the use of prepayment penalties in circumstances where they might trap borrowers in unaffordable loans.

In addition, for all mortgage loans, our proposal addresses misleading and deceptive advertising practices, requires borrowers and brokers to agree in advance on the maximum fee that the broker may receive, bans certain practices by servicers that harm borrowers, and prohibits coercion of appraisers by lenders. We expect substantial public comment on our proposal, and we will carefully consider all information and viewpoints while moving expeditiously to adopt final rules.

The effectiveness of the new regulations, however, will depend critically on strong enforcement. To that end, in conjunction with other federal and state agencies, we are conducting compliance reviews of a range of mortgage lenders, including nondepository lenders. The agencies will collaborate in determining the lessons learned and in seeking ways to better cooperate in ensuring effective and consistent examinations of, and improved enforcement for, all categories of mortgage lenders.

The Federal Reserve continues to work with financial institutions, public officials, and community groups around the country to help homeowners avoid foreclosures. We have called on mortgage lenders and servicers to pursue prudent loan workouts and have supported the development of streamlined, systematic approaches to expedite the loan modification process.

We also have been providing community groups, counseling agencies, regulators, and others with detailed analyses to help identify neighborhoods at high risk from foreclosures so that local outreach efforts to help troubled borrowers can be as focused and effective as possible. We are actively pursuing other ways to leverage the Federal Reserve’s analytical resources, regional presence, and community connections to address this critical issue.

In addition to our consumer protection efforts in the mortgage area, we are working toward finalizing rules under the Truth in Lending Act that will require new, more informative, and consumer-tested disclosures by credit card issuers. Separately, we are actively reviewing potentially unfair and deceptive practices by issuers of credit cards. Using the Board’s authority under the Federal Trade Commission Act, we expect to issue proposed rules regarding these practices this spring.

Although the FOMC participants’ economic projections envision an improving economic picture, it is important to recognize that downside risks to growth remain.

The latest economic projections, which were submitted in conjunction with the FOMC meeting at the end of January and which are based on each participant’s assessment of appropriate monetary policy, show that real GDP was expected to grow only sluggishly in the next few quarters and that the unemployment rate was seen as likely to increase somewhat. In particular, the central tendency of the projections was for real GDP to grow between 1.3 percent and 2.0 percent in 2008, down from 2-1/2 percent to 2-3/4 percent projected in our report last July.

FOMC participants’ projections for the unemployment rate in the fourth quarter of 2008 have a central tendency of 5.2 percent to 5.3 percent, up from the level of about 4-3/4 percent projected last July for the same period. The downgrade in our projections for economic activity in 2008 since our report last July reflects the effects of the financial turmoil on real activity and a housing contraction that has been more severe than previously expected.

By 2010, our most recent projections show output growth picking up to rates close to or a little above its longer-term trend and the unemployment rate edging lower; the improvement reflects the effects of policy stimulus and an anticipated moderation of the contraction in housing and the strains in financial and credit markets. The incoming information since our January meeting continues to suggest sluggish economic activity in the near term.

To help relieve the pressures in the market for interbank lending, the Federal Reserve–among other actions–recently introduced a term auction facility (TAF), through which prespecified amounts of discount window credit are auctioned to eligible borrowers, and we have been working with other central banks to address market strains that could hamper the achievement of our broader economic objectives. These efforts appear to have contributed to some improvement in short-term funding markets.

However, where pertinent and when available, data through mid-April 2008 are included and discussed in this report.

Exports and imports of goods and services to and from the countries whose economies and currencies are discussed in this report accounted for about 85 percent of total U.S. trade in 2007.

U.S. Macroeconomic Trends

The economy slowed toward the end of 2007, buffeted by the decline in residential building and related financial market turmoil, as well as significant increases in energy prices. Job growth moderated, and the unemployment rate moved higher.

Headline inflation picked up as energy prices surged but core inflation remained contained. Financial markets became increasingly unsettled during the late summer of 2007, reflecting concerns about the quality of debt instruments backed by subprime mortgages. The Federal Reserve cut the federal funds interest rate target by 50 basis points in September. Additional rate cuts followed in October, December, January, March and April 2008. Yields on long-term securities fell in the second half of 2007 and continued to trend down in early 2008. The economy is expected to remain weak through the first half of 2008 but improve in the second half when measures enacted under the Economic Stimulus Act of 2008 take effect.

Slowing Economy

Real GDP growth slipped to a 0.6 percent annual rate in the fourth quarter of 2007 from the rapid 4.4 percent pace averaged in the second and third quarters. Growth moderated across all spending categories, but a large part of the slowdown was due to a drop in private inventory investment, which subtracted 1.8 percentage points from fourth-quarter real growth after adding 0.8 percentage points in the third quarter.

Consumer spending – which accounts for 70 percent of economic activity – eased to a 2.3 percent annual rate of growth in the fourth quarter from 2.8 percent in the third quarter. Business investment activity also cooled at the end of 2007, with real outlays for equipment and software up by just 3.1 percent at an annual rate, half the pace recorded in the third quarter. On the plus side, growth of business spending on structures remained solid, while exports continued to post strong gains.

The ongoing contraction in residential construction remained a drag on the economy in the fourth quarter. Real residential investment plunged by 25 percent at an annual rate, shaving 1.3 percentage points from real GDP growth. That followed a 21 percent drop in the third quarter that subtracted 1.1 percentage points from real growth. Over the four quarters of 2007, declining residential investment reduced real GDP growth by nearly a full percentage point, about the same as in 2006.

Recent data indicate that housing activity continued to contract in early 2008. Housing starts fell to a 17-year low in March, with starts of single-family homes down a steep 63 percent from their January 2006 peak. Sales of new single-family homes also fell to a 17-year low in March and resales of existing single-family homes remained near their lowest point in the past 10 years. Home prices continued to fall below year-earlier levels in February. Forward-looking indicators suggest that housing will weigh on growth throughout 2008.

Inventories of unsold homes are at historically high levels, building permits remain well below starts, and homebuilder optimism is close to an all-time low. Mortgage delinquencies and foreclosures have risen sharply over the past year and are projected to climb further in 2008, adding to the inventory overhang and putting additional downward pressure on home prices.

Labor market conditions also weakened in the second half of 2007. Job growth moderated to 76,000 per month on average, down from an average monthly gain of 107,000 in the first half of the year. The unemployment rate rose to 5.0 percent in December, up from a recent low of 4.4 percent in March 2007. Real wages began to fall in late 2007 as consumer price inflation accelerated. Over the twelve months of the year, real hourly earnings for production workers declined by 0.7 percent. Real earnings rose by 1.8 percent during 2006 after falling in 2004 and 2005. The labor market deteriorated further in early 2008. Nonfarm payroll employment fell by 260,000 in the first four months of the year – the first decline since August 2003. The unemployment rate was 5.0 percent in April 2008.

The MSCI developed country stock index fell by 1 percent in the second half of 2007, whereas the emerging market index rose by 17 percent. Credit spreads in emerging markets increased, however, as the crisis unfolded in August, and have continued to rise. The EMBI+ spread ended the year up 70 bps, the first increase since 2002. Most of this increase occurred in the second half of the year.
Strong economic fundamentals, better institutional foundations, and stockpiles of international reserves make many emerging markets less vulnerable than during previous periods of global financial turbulence.
Capital Flows of Emerging Market and Developing Economies 2006 2007 2008f Net Private Capital Inflows ($ Bil) 231.9 605.0 330.7 Current Account ($ Bil) 698.0 738.1 814.7 Increase in Reserves ($ Bil) 752.8 1,236.2 1,004.1 Note: “f” indicates forecast. Source: IMF, World Economic Outlook, April 2008
Private net capital inflows are expected to slow this year, but remain well above the $177 billion average for 2001-06. In addition, the aggregate current account surplus in emerging markets and developing economies, which rose to $738 billion in 2007, is expected to increase to $815 billion in 2008. This would mark the seventh consecutive annual increase in the current account surplus for this group of countries.

[ Etc. ]

In the second half of 2007, U.S. exports (BOP basis) totaled $601.4 billion. Of this, exports of capital goods accounted for 38.5 percent, exports of industrial supplies 27.6 percent and exports of consumer goods 12.5 percent. Imports (BOP basis) in the second half of 2007 totaled $1,010 billion, of which 33 percent were industrial supplies (including petroleum and petroleum products), 23.7 percent were consumer goods and 22.4 percent were capital goods. Imports of petroleum and petroleum products totaled $181.9 billion in the second half of 2007 compared to $149.2 billion in the first half, an increase of 21.9 percent.Capital and Financial Accounts
By balance of payments accounting definition, the counterpart to the balance on the current account is the balance on the capital and financial account. Since by definition the current account balance is the difference between domestic capital formation and domestic saving, the net of flows in the capital and financial account are equal to the excess of net capital formation over domestic saving.
Data for 2007 show that U.S. residents invested more abroad in the form of direct investment than foreign residents invested in the United States.

[ . . . ]

The U.S. Treasury’s International Capital Reporting System (TIC), which records cross-border transactions data, shows continued strong demand for U.S. financial assets, even if the negative months of August and September 2007 are included (those months saw significant outflows during the onset of the financial turmoil). Total net foreign demand for U.S. long-term securities was $1,006 billion in 2007 compared to $1,143 billion in 2006 and $1,012 billion in 2005.

[Etc. – great charts, too – so completely out of touch with the unfolding disaster which is evident throughout the text, graphs and projections

Semiannual Report on International Economic and Exchange Rate Policies

To view or print the PDF content on this page, download the free Adobe® Acrobat® Reader®.
To view or print the Microsoft Word content on this page, download the free Microsoft Word Viewer. The Treasury Department’s Report to Congress on International Economic and Exchange Rate Policies outlines the currency practices of America’s major trading partners.

Mission

The Office of Economic Policy is responsible for analyzing and reporting on current and prospective economic developments in the U.S. and world economies and assisting in the determination of appropriate economic policies. The Assistant Secretary for Economic Policy reports directly to the Secretary of the Treasury and is responsible to him for the review and analysis of both domestic and international economic issues and developments in the financial markets.

The Office participates, along with the Council of Economic Advisers and the Office of Management and Budget, in the preparation of the Administration’s budget. Economic Policy supports the Secretary of the Treasury in his roles as Chairman and Managing Trustee of the Social Security and Medicare Boards of Trustees. The Office conducts research to assist in the formulation and articulation of public policies and positions of the Treasury Department on a wide range of microeconomic issues. Recent examples include terror risk insurance, financial disclosure and auditing, stock options, parallel imports, health insurance, retirement income security, and long-term care.